Is this the right time to invest in fixed income instruments?

Ever since the Reserve Bank of India (RBI) raised repo rate in the unexpected monetary policy meet in May 2022, the repo rate rose by a total of 225 basis points last year. The rising rate cycle ensued higher debt yields, making the fixed income instruments more attractive, shows ICICI Prudential AMC Annual Outlook 2023.

As the equity market valuations and debt instrument yields are moving higher, the fixed income instruments become more attractive, shows the report.

The report also indicates that it is the right time to invest in fixed income instruments because yield gap model (G-Sec rate minus Nifty50 earnings yield) has risen to 2.98 percent.

A Bloomberg report said that fund managers and other large investors are buying short-term bonds as there are increased chances of RBI pausing interest rate hikes in the near future.

(Source: ICICI Prudential AMC)

As one can see in the table above, the repo rate rose by 225 basis points to 6.25 percent between September 2021 to December 2022; the returns delivered by commercial papers surged by 3.6 percent during the same period.

At the same time, the 1-year AAA bonds gave 3.35 percent higher return, 2-year AAA bonds gave 2.77 percent higher return and 3-year AAA bonds gave 2.28 percent more return than given in the past.

Manish Banthia, Deputy CIO, Fixed Income, ICICI Prudential AMC says that one-to-two year portion of the curve is attractive from an investment perspective. “So, investors can consider investing in short duration schemes, dynamic bond or credit category scheme. Adding duration through the long end of the curve is unlikely to be beneficial,” he said.

While elaborating on the reasons that make these debt instruments attractive, Mr Banthia says: “We believe the RBI will pause rates for a longer period of time after a round or two of rate hikes. This is a typical characteristic of an economy in mid-cycle; a phase we believe India is in currently. The RBI is now content with inflation hovering around 6% unlike previous times where the focus was on 4% inflation. We are of the view that the RBI will not be in a hurry to reduce interest rates in this part of the economic cycle.”

ALSO READ: Funds rush to buy short-term bonds as RBI expected to end rate hike cycle 

He adds, “With an additional 25 bps rate hike, at a repo rate of 6.5 percent and an average inflation of 6 percent, the rates are not restrictive in nature to cause an economic slowdown. We believe the economy will continue to expand with overall monetary policy being supportive of growth.”

Note: This story is for informational purposes only. Please speak to a SEBI-registered investment advisor before making any investment related decision.